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Overview

Attaching a fair and accurate price tag to your products and services can be a tricky balancing act. It should come as no surprise that many business owners have an ongoing struggle with setting their pricing strategies. Some use inappropriate approaches, for example, attempting to always be the lowest-priced player in the market, while others fail to change their approach to capitalize on market changes.

As you know, the success of your products and services relies directly upon your ability to sell them, which in turn is dependent upon your pricing strategy. If your prices come in too low, you won't make a reasonable profit. Go too high, and you may weaken the demand for your offerings. But the truth is you don't have to be a magician to get pricing right.

There are some simple, yet definitive measures you can take to accurately price your product or service. By exercising creative judgment and a keen awareness of consumer motivations, you can greatly increase your chances of owning the market. The following road map will guide you through the pricing maze and set your company on the road to accurate pricing.

Outline:

1. The Importance of Accurate Pricing
2. Conducting Market Research
3. Pricing Models
4. Pricing for a Service or Consulting Company
5. Raw Costs for Services and Consultants
6. How to Determine If Prices Are Working for You
7. When to Raise or Lower Prices
8. Prices and the Law
9. Resources

I. The Importance of Accurate Pricing

Up until now, your pricing strategy, like that of many entrepreneurs, may have been rather elementary: Determine what your competitors are charging, then charge a little less. Being the lowest-priced product or service on the market, however, does not guarantee success. In fact, it could create just the opposite effect, because for most customers, buying a product or service isn't just about price, but rather about value.

Customers want the best value for their money, and thus they will almost always do a quality comparison and make purchases based on the best price for the best value. To illustrate, put yourself in your customer's position. Suppose you go into an office-supply store to buy a ream of paper for your printer, and you find that there are dozens of options to choose from. As you scan the shelves, you notice that most reams cost about $7.99, but you notice one ream for $5.99. You may be tempted to pick it up, but if you're like most consumers, you automatically think to yourself, "Why is this so cheap? Maybe the quality isn't as good, and maybe it will jam my printer. Or maybe the ink will bleed through." To ease your mind, you likely buy one of the higher-priced reams.

You also don't want to price your product too high because consumers may think it's unreasonable and, therefore, will not buy it. Remember, you assign a price tag to your product or service because you want and need to sell it. If customers aren't willing to pay for your product or service simply because you have priced it out of the ballpark, you may be left with a warehouse filled with product that you can't move - and a company that is heading for financial woes.

As with most rules, however, there are exceptions when it comes to pricing. For example, if you have a product or service that is in exceptionally high demand, you will usually be able to get away with selling it at a higher price. Remember a few years back when Mazda came out with the Miata, and the little sports car sold like hotcakes? Mazda was able to capitalize on that boom and raise the car's price because the demand was so great that consumers were willing to pay the extra money. Similar circumstances happen every year around Christmas with must-have toys for children, as was the case with Cabbage Patch Dolls in the late '80s and Tickle-Me Elmos in the 1990's. When you have such products that are "all the rage," you can set your own prices.

Another time you may get away with overpricing is if your product or service is perceived by the public to be worth more because of your company's brand name. For example, a bottle of perfume may have $10 worth of perfume in it, but add the name "Calvin Klein" or "Chanel" to the bottle, and suddenly the perfume sells for $50. These are situations in which the highest-priced products will be purchased by status-seeking consumers because of their perceived value, whether it is a reality or not.

Additionally, if you are in an industry where the products change quickly, such as high-tech, you may have to set prices a little higher, knowing that you only have a small window of opportunity in which to sell. The computer industry is a prime example of this: What is on the market today may well be defunct in a year or two. Thus, this is one of those rare cases where you may have to overprice in order to sell quickly and make a profit.

At the other end of the spectrum, by setting prices too low, you not only risk hurting your profit margin, but you also risk customers perceiving your product or service as inferior to others on the market. There are situations, however, in which consumers will go with the lowest-cost product without question of value, as is the case with some generic-brand items and products found at discount-shopping centers and outlets. If you find that your customers value low prices over high quality, a lowest-price approach may be appropriate for your company.

Remember this golden rule when setting prices: perception is everything. How customers view your product or service and what they are willing to pay for it is based upon those perceptions. In the end, customers will tell you loud and clear through their purchasing behavior whether or not your prices are too high, too low or right on the money.

The following questions are designed to help you determine whether or not you have set accurate prices for your product or service.

1. How do my customers perceive my product or service, in terms of price and value?
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2. How do my prices compare with my competitors?
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3. What values and benefits do my customers get from my product or service?
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4. Are my prices consistent with those benefits and values?
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5. What is the current supply-and-demand relationship of my product or service?
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6. Am I in an industry where the demand for my product or service has a short life cycle, and thus I need to cash in quickly?
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7. Do I have a product with a recognizable name that allows me the luxury of overpricing?
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II. Conducting Market Research

Market research is required if you intend to gain a competitive advantage through pricing. You'll want to use research to determine what competitors are charging for products or services similar to yours and assess how your offerings measure up in terms of quality compared to those competitors. Knowing this will help you determine a fair price.

There are many ways to conduct market research, including the Internet, trade publications and trade shows. You can also go out and physically shop the competition, or if you are too busy or too recognizable to do so, you can hire professional shoppers to do it for you.

When conducting market research, don't be afraid to go straight to the customer. One company that performs valuable market research with customers is multimedia sound technology innovator Bose Corporation. When Bose introduces a new stereo speaker, for example, the company often takes it right into retail stores to show it to prospective buyers. Company representatives use the opportunity to ask potential buyers what they would expect and be willing to pay for a speaker of that caliber. This firsthand information gives the company a good idea of the price they should set when they introduce that product to the market.

For additional help on this topic, see Conducting A Market Analysis, Identify Your Target Market and Analyze Your Competition.

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III. Pricing Models

While the beat-the-competition pricing approach may work for some, there are many other complexities involved in establishing a pricing strategy. In addition to the market value of your product or service, your prices will, to a degree, be influenced by external factors that are out of your control. For example, if you are bringing a product to the market for the first time, you will have some start-up costs that you will want to recoup. These expenses will include research, manufacturing, staff, machinery, equipment and packaging.

To illustrate how these costs affect your product's cost, consider the following example. Let's say that you start a company selling handmade dolls, and your start-up costs are $200,000. We'll assume that it costs you $2 in time and materials to produce each doll. For the purpose of this exercise, we will assume that supply and demand are equal, and you can sell the number of dolls that you can produce. Let's also say you can produce 100,000 dolls per year at a cost of $2 per unit, which equals another $200,000. If you add this number to your original start-up cost, the total is $400,000. Now, to determine your price, you must decide if you want to break even — recoup all of your original costs and nothing more — or if you want to make a profit. If your plan is to break even during the first year of operation, then you will need to price the dolls at $4.

If a profit within the first year is important to you, you must add into the equation exactly how much profit you intend to make and adjust your price accordingly from there. For example, if you want to make $100,000 in profit during this time period, you would need to raise the price to $5, and the equation would look like the following:

It is important to remember that pricing models aren't etched in stone. As you move through the production phase, you may incur some unanticipated costs. It is crucial that you add these costs to the equation in order for it to be accurate, so you won't be surprised or disappointed down the line.

It's important to note that pricing models are the same for services, including consulting, as they are for products. While you may not have the huge start-up costs with service companies, you will still most likely need to put out some money up front. Say you are a management consultant, and you must rent office space, furnish it, and buy supplies. You may also need to pay a salary and benefits to a secretary or receptionist, and you may have some advertising costs. It is all of these hidden, often forgotten costs that must be factored into your pricing model. Remember, the key here is to list every penny you will spend up front, then figure in how much profit you want to make in a year, and then you will have an accurate price for your product or service.

Whether you own a product or service business, use the following self-assessment to insure you have the proper equation for your pricing model.

1. Have I accurately figured my start-up costs? If so, what are they?
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2. What is my cost-per-unit?
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3. In determining my cost-per-unit, have I figured in all money spent, including labor, supplies and packaging?
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4. How many units can I produce or services can I provide in a year?
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5. Do I want to make a profit in the first year, or will I be content to just break even?
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6. If I want to make a profit within the first year, what is an attainable profit goal? Has that number been added to my pricing equation?
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VII. When to Raise or Lower Prices

From time to time after developing price structures, external factors beyond your control may come into play and make you re-think your pricing strategies. These factors can include changes in economic conditions, supply and demand, and competitor's prices - all of which will have a dramatic affect on how you price your product or service.

Like it or not, you may be forced to raise or lower your prices based on the information at hand. (Note: the following is a general discussion of the theory of price alterations. It is recommended that you consult a financial professional about your own particular circumstances.) Economic conditions, such as inflation, a recession, a boom, and rising or falling interest rates will directly impact how you price your product or service at certain times because they affect both your production costs as well as how much money your customers are willing and able to spend. Obviously, in times of recession, people will spend less money, especially if they perceive your product or service to be a luxury. It is during these hard times that you may want to consider temporary price cuts to help get you through the rough period.

There are several other circumstances that may lead you to consider lowering your prices. One is excess capacity. Simply put, this means that you need to generate additional revenue but can't seem to do it through increased sales efforts or product improvements. You may also choose to initiate a price cut to gain market share through lower costs. While you may be hesitant to cut prices because you fear that it will further reduce your profit margin, it may in fact raise revenues through higher volumes of sales.

It is also possible that in time, you may discover new ways to produce your product cheaper. You will then have a choice: keep the extra money as profit or pass along the savings to your customers. Strange as it may seem, by putting that money into your customer's pocketbooks, you could actually increase your sales because you could gain more customers, which in the end could of course translate to even more profit.

It is also likely that at some point in time, at least one of your competitors will lower their prices. When this happens, you must re-examine your pricing strategy. In order to stay competitive, you may be forced to lower your own prices. This will be especially true if other competitors slash prices to follow suit.

There are a few creative ways to make customers believe you are lowering your prices when in reality you are not. For example, if you sell a television set for $300, and you drop the price to $295, even though it is only a $5 reduction, customers psychologically place that television in the $200 range. There are many variations on this strategy; for example, pricing products at $29.99 or $29.95 has been shown to be much more appealing to consumers than $30.

You may also choose to lower prices temporarily through discounts and coupons. This is the best way to lower prices, because when the discount period has passed, you are free to go back to your normal prices. You may consider buy-one-get-one free promotions, rebates, percentages off, select customer appreciation sales, and so on. It is important that you not overuse this tactic, as it is very hard to go back to original prices once customers get used to the discounts. They will view the return to normal prices as a price increase, which may lessen their interest in purchasing.

At times, there is no way around raising prices. You must approach this gingerly, knowing full well that many of your customers will resent it. In fact, you may even lose customers because of it. But don't apologize for doing what you have to do to maintain a healthy business. For a small increase in price can mean a considerable increase in profits. What are some circumstances that might force you to raise prices? The most common one is inflation. Rising costs, unequaled by productivity gains, put a big squeeze on profit margins. In order to reach the profit goal set in your pricing model, raising prices may at some point become inevitable.

Another circumstance that can lead to raising prices is an increased demand for your product or service. In this situation, an increase in prices may be necessary to cover the costs of meeting customers' needs, including purchasing more inventory, hiring more staff and/or leasing new office space. If you find yourself having to raise prices for these or other reasons, you should always let customers know the reasons behind the decision. Most consumers will be understanding, especially if you have won their loyalty with quality products and services.

Whether you raise or lower your prices, there is another group directly affected by your decision: your competitors. You must assume that there are at least a few companies watching your moves, just as you watch them. Once you make a move, they will most likely react strategically to retain or gain market share. Other competitors may join in the race and change their prices to be more in line with yours, sparking an all-out price war.

Ask yourself the following questions regarding your prices.